Mutual-fund firm sparkles in decade

Sunday

Nov 28, 2010 at 12:01 AMNov 28, 2010 at 10:41 AM

decade ago, stock markets were flying high as Internet companies reached stratospheric valuations despite never having made a profit. Warren Buffett's "buy good companies for a fair price" philosophy had fallen out of favor.

decade ago, stock markets were flying high as Internet companies reached stratospheric valuations despite never having made a profit. Warren Buffett's "buy good companies for a fair price" philosophy had fallen out of favor.

It might have seemed an odd time to start an investment-advisory firm in Columbus, of all places, with the old-fashioned philosophy of buying stakes for the long term in well-managed companies that appear to be cheap.

But Diamond Hill Capital Management has thrived in its 10 years, consistently outperforming its thousands of competitors in the mutual-fund industry.

The company, based in the Arena District, has since grown to manage $8 billion in seven funds, despite the turbulent stock markets and the near-collapse of financial markets two years ago.

Its share price has skyrocketed from less than $3 in 2003 to above $80, not counting the $20 per share in special dividends that it has paid out in the past two years. The company has a market value that tops $200 million.

At the time the company was created, stock markets were suffering from what Ric Dillon, Diamond Hill's CEO and chief investment officer, called "irrational exuberance," borrowing the phrase from former Federal Reserve Chairman Alan Greenspan. Greenspan used the phrase in 1996 amid the dot-com bubble that was building and then burst, paving the way for the return of the kind of investing made famous by Buffett.

"It was a great opportunity for a different kind of investing," said Dillon.

"We've been able to gain business because we are doing better than average."

What Diamond Hill does

Diamond Hill operates seven mutual funds, all of which draw on Buffett's philosophy. The funds are meant to be held for at least several years, on the theory that strong investments will pay off over time.

"It's the system we were taught," he said.

"We are always comparing price and value," Dillon said, with the ultimate question in mind: "What is a company really worth?"

Investors in the funds include state and corporate pension funds, insurance companies and individuals who buy into the funds through financial planners and advisers.

The company makes money by collecting a fee on the investments that it manages, averaging about 0.65percent per year.

The company can increase revenue by attracting more money from investors to manage. The way to draw in more money is to outperform competitors and benchmarks over time.

"When they say they find the intrinsic value in a company, I really believe they know how to do that," said Anthony Reilly, partner and founder of Ascend Advisory Group in Dublin, whose clients invest in Diamond Hill funds and buy shares of the company.

"They try and pay a price below that intrinsic value and hold that until there is some premium. That's truly investing."

The beginning

Diamond Hill is actually the re-creation of a company once known as Bank Stock Group that was incorporated in 1977. Bank Stock made a market buying and selling shares of small community banks that otherwise could be difficult to trade. The company went public in 1993.

Dillon, a former portfolio manager for Boston-based investment house Loomis, Sayles & Co., and his firm, Dillon Capital Management, were brought in to look at Bank Stock Group, which was not profitable, and to build an investment advisory business. In 2001, the company's name was changed to Diamond Hill to reflect the company's new focus.

Dillon, 54, is a central Ohio native. He grew up in Newark and went to Ohio State University. After leaving Loomis, Sayles after it had bought his company, he was looking to return to Columbus to start another investment-advisory company.

Dillon not only had family and friends here, but returning to Columbus also allowed him to draw on the expertise of his former colleagues at Dillon Capital who remained in Columbus.

Dillon and Reilly were former neighbors in German Village.

Reilly, formerly president of a Bank Stock subsidiary, introduced Dillon to the company's board and came up with the Diamond Hill name, taken from a mountain in his home country of Ireland.

Dillon said joining up with Bank Stock Group rather than starting a firm from scratch made more sense. The company's $10 million in cash on hand allowed him to build a bigger firm faster.

The company lost $7 million in the first four years. It has made more than that in the first three quarters of this year: a profit of $7.9million. Revenue has risen 38 percent this year to $41.2million.

The staff of five has grown to 62, including 19 research analysts and seven portfolio managers overseeing the company's funds.

"We've had a good performance, essentially going from zero to $8billion in the first 10 years," Dillon said.

"It's been a great first 10 years, better than anyone expected."

The investment philosophy

Dillon is the first to admit that there is nothing new in the company's investment philosophy. It was a style that had fallen out of favor in the 1990s, when stock markets were roaring.

Diamond Hill picks its investments for its seven funds by studying the cash flow of thousands of companies whose shares are traded on stock markets.

"It was the good practice of that philosophy that led to good results," he said of the funds' gains over the years.

The company tends to judge its performance by how investments do over five years. That levels out the ups and downs that occur in any market and investment.

Granted, making any money from investments in stocks in the past decade has been a challenge. The Dow Jones industrial average, despite dramatic swings from record highs to multiyear lows, has basically been flat.

Still, the Diamond Hill fund that invests in smaller companies has outperformed its benchmark by an average of about 5 percentage points a year since its inception 10 years ago.

Diamond Hill's fund that invests in large companies has outperformed its benchmark by an average of 3 percentage points a year since it was started nine years ago.

Dillon believes that stock markets can post gains in the next five years. He expects the S&P 500 index, which represents the biggest companies in the U.S., to rise by an average of 6percent per year, including dividends, as corporate profits continue to grow, helped by the strengthening of economies around the world.

That means there could be one or two years when the S&P 500 falls, but it also means there might be one or two years when it rises by 10percent or more, he said.

Investors who buy into Diamond Hill funds would not want to put all their money into the company's funds. Diamond Hill, for example, has no funds that invest in overseas companies or funds that are focused on bonds or other kinds of investment strategies.

Andrew Gogerty, a senior fund analyst for Morningstar, which monitors mutual funds, said Diamond Hill portfolio managers are good stewards of investors' money. Fees are low, managers invest their own money in their funds, and investors have access to commentary, financial reports and other data to keep them informed.

Gogerty said the firm is not concerned about short-term price swings or market sentiment.

"They are very unassuming," he said. "They have a very clear understanding of what they do well, and what they don't."

mawilliams@dispatch.com

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